When the equity market falls nearly 10% within two weeks there is an interesting shift in the psychology of participants. You can feel the heightened level of anxiousness. Many stock market traders are long and wrong.
After months of a slowly up-trending market many traders become lulled into a false sense of security. Any stock traders that try to short the market are gradually squeezed out of their positions by this slow uptrend until there are very few shorts left.
Then all of a sudden the stock market snaps and 7—8 months’ worth of buying is out of the money in the blink of an eye. This creates an enormous weight above the market and until we have the final capitulation of these weak hands the stock market will not be ready to go up again.
ASX 200 Daily Chart
Out of the money traders are watching the screens like hawks and hoping that the stock market rallies so that they can be made whole. This is what ends up creating enormous resistance at the ‘point of control’ of the current distribution.
Current Distribution For ASX 200
If you have a look at the ASX 200 chart again you can see that the current distribution that our market is in lies between 4075—4325 (the solid blue lines in the chart). A range that began in August 2011. The point of control of that structure is at 4200. That is the gravitational point around which all of the subsequent price action is oscillating.
In my stock market update on the 8th of May, which you can find here, I warned anyone who would listen that they should be looking to sell the market due to the false break of the high of the structure. I gave targets at the time down to the bottom of the distribution at 4075, which is where we are now.
This begs the question: ‘Where to from here?’
I think the chance of a short squeeze of some sort happening from here is very real.
The Commitment of Traders data released over the weekend showed a distinct change of position by the big boys.
Commitment of Traders E-mini S+P 500
The dealers cut short positions and increased long positions by a total of nearly 120,000 contracts. Leveraged funds did the opposite, cutting long positions and increasing short positions. This is the sort of thing that makes the market ripe for a squeeze. I would usually expect the dealers to be right with their positioning, and a large increase in shorts by the hot moneyed leveraged funds can ignite some strong buying if things turn around.
Also, you would expect to see strong support in our market at the bottom of the distribution (4075). Having fallen nearly 10% in two weeks it is only natural that some buyers will step in looking for bargains.
I don’t believe this rally will turn into anything substantial though. My expectation would be that any rally from here could take us back to the point of control at 4200. This is the midpoint of the distribution and is the point where most of the trading and thus positions have been accumulated.
As I said before there are plenty of stock market traders who are long and wrong, hoping to be made whole again. When given the chance they will happily dump their positions, which will create the ‘weight’ above the market that I was talking about. A best case scenario would see a rally all the way back up to 4325, which is the top of the distribution. If that were to occur I would be an aggressive seller. I don’t think I will be given the chance to short the market up there, but who knows. A short squeeze will often go further than you think. It is imperative to be patient during the short squeeze phase of a market.
Longer term I remain firmly bearish and expect to see our market retesting last year’s lows at 3800 over coming months. If Europe completely unravels we may head even lower.
There are concrete signs of slowing in Chinese demand for commodities. The property market over there is looking very shaky indeed, so don’t be surprised to see a stock like BHP trading in the low $20’s, as crazy as that may seem.
The wild card, as always, is central bank intervention. I think it is coming, but I don’t think it will happen before the market is a lot lower than it is now. Plenty of stock traders were buying the market a month ago, thinking that they were going to get free money due to the printing presses. I don’t think Bernanke and Co. want to print while the equity and commodity markets are trading at multi-year highs. They would much prefer to wait until things are selling off hard, so that everyone is pleading with them to ‘do something’ to save the world. Then the inflation that they unleash will be from much lower levels, rather than stoking the markets higher and higher.
Also they know that they only have so many shots at the The Early Stages of a European Bank Run
2012-04-21 — Dan Denning